Testing times for the accounting profession: Something must give!

18 Apr 2018

That the accounting and auditing profession is tainted is no longer in dispute. But fate has presented a wonderful opportunity to fix the profession. And the first thing we need to do is get rid of the board of the South African Institute of Chartered Accountants (SAICA). They are clueless, uninspiring, distracted, conflicted and quite simply unfit for this job.

By Khaya S Sithole
In the winter of 1861, Charles Dickens produced one his finest pieces of work – Great Expectations. At the heart of the story is the tale of an orphan – Pip – who is born into circumstances of dire poverty. His unfortunate entry into the world notwithstanding, Pip gets a benefactor who seeks to transform him into a ‘gentleman’ of sorts so that he can be a normal member of society. Through the journey of his transformation, Pip is convinced that his benefactor is a wealthy lady of means. It later transpires however, that his benefactor is a thief and convict who decided to give the young man an opportunity to be something better.

Pip’s journey up the social ladder seems to coincide with a decline in his ethical compass. The richer he became, the poorer he turned out to be. Despite his elevation to the rank of a gentleman, Pip remains hamstrung by the historical burden of his status as an orphan. It is when he realises how much he has lost as a human being that Pip utters the famous words – “For an hour or more, I remained too stunned to think; and it was not until I began to think, that I began to fully know how wrecked I was, and how the ship in which I had sailed was gone to pieces…”

And it just turns out that in 1861, a small auditing firm was renamed James & Henry Grace. This firm would eventually merge with a few other firms over the intervening decades to form the roots of what we now call KPMG. From the moment the firm was created, it played into the rarefied space of auditing public and private entities. Such a space is currently dominated by 4 firms across the globe – KPMG, PwC, Deloitte and EY.

The nature of the work they do is so fundamentally important, and their opinions so valuable, that no other cohort of 4 private entities has such an influence into the daily activities of people across the world. What has earned the firms such a reputation and the associated prestige is naturally the high level of trust we place on them. Such is the nature of our relations with auditors we routinely accept and believe most information that is published simply because it has the stamp of an auditor.

Which is why the KPMG case in South Africa is such a universal calamity for all of us.

The cartel called The Big Four

Over 12 months ago, we were engaged in an intense debate about the idea of mandatory audit firm rotation in South Africa. The essence of the debate centred around the question of whether companies should be forced to periodically change their auditors in order to ensure independence and objectivity are maintained. This was motivated by the fact that the basis for the trust relationship that auditors enjoy is the independence and objectivity that auditors should exercise when conducting their audits.

When this is compromised, the trust relationship gradually gets eroded. For relationships that last for over 100 years, the independence perception has long been lost and hence a case for changing auditors exists. After I made my submissions to Parliament I was obviously attacked by fans of the Big 4 and its primary defenders – the South African Institute of Chartered Accountants. The basis of the defence by the auditing cartel was simply that their systems and processes were good enough as they were and required no intervention whatsoever.

But as it turned out, the true picture was far from the image projected by the cartel and SAICA.

Firstly, there was the KPMG-Gupta debacle. This debacle – more than 10 years in the making – resulted in SAICA deciding to commission an independent inquiry into the affairs of members involved in the KPMG audits of Gupta entities. The problem I highlighted from the inception of this inquiry is simply that it will simply turn out to be the biggest waste of financial resources in the history of the profession. Firstly, in spite of what SAICA thinks of itself, it is in reality nothing more than a glorified members network whose members pay an annual membership fee based on the idea that there is some value in being associated with the brand. But more crucially, the very idea that SAICA could do anything independent relating to KPMG is simply laughable.

KPMG are indeed the auditors of SAICA – and in a cruel twist of fate – replaced those other interesting auditors called Nkonki. In other words, SAICA would have us believe that they are in a position to conduct an independent, credible and objective investigation into their own auditors. This is absolutely nonsensical. Additionally, as a members alliance with little legal standing in the Republic, it is actually unknown by anyone at SAICA what exactly will be the consequences of whatever it is that they seek to find in this inquiry. If it turns out that Auditor XYZ for example, was less than competent in conducting the audit of the Gupta wedding, the best he can hope for is a letter advising him that the institute no longer wishes to associate with him and terminate his membership. Whether individuals like Markus Jooste, Anoj Singh, James Aguma and their entire WhatsApp group actually care about such an association is of course open for debate.

Perils of association

And there is then the question of the perils of association. In relation to the KPMG saga, the various clients that have terminated their mandates are not themselves victims of dodgy work by KPMG but rather do not wish to be associated with the firm. For a profession that specifically highlights the importance of being seen (by stakeholders) as independent it is remarkably bizarre that SAICA itself insists on keeping KPMG as their auditors. The fact that
its members across the country are aggrieved by the decline in the reputation of the profession as a whole seems to have failed to make an impression on the SAICA board. So even today, after the SARS Rogue Unit report, the Gupta debacle, the VBS scandal and all its associated implications, the board of SAICA still labours under the impression that KPMG are the best people to conduct SAICA’s audit.

Another entity that initially took a conservative view on the KPMG matter is the Office of the Auditor-General. Last year, when asked whether they would be terminating their relationship with KPMG, the Auditor-General opted for a wait-and-see approach instead of cutting ties altogether. Back then, the most prominent issue at hand related to the SARS report and the Gupta scandal. And at that stage, it was still possible to assume that the issues were isolated
incidents within the firm.

Unfortunately, the revelations of this month alone have left us all thinking that actually, the problem at KPMG is far more pervasive than previously thought. In light of this, the Auditor-General has then taken the unprecedented step of cutting ties with KPMG and Nkonki. This makes sense for a variety of reasons.

The fact that the Big 4 firms make millions of money from public sector work they do on behalf of the Auditor-General is an open secret. The Auditor-General’s constitutional mandate gives it the first right to audit all public sector entities. In instances where it has limited capacity then it is able to outsource the work to firms like KPMG. Such a practice has been very profitable for firms like KPMG.

But of course, public sector audits are no ordinary business spaces. There are always the intersections with politics. And in this case, the possibility that politicians can now reject audit reports simply because KPMG prepared them would create a governance crisis and a monumental headache for the AG. Given the nature of the political environment we live in, there is no need to create an additional reason for people to reject audit reports simply because they doubt the credibility of KPMG. The Auditor-General is then left with little choice but to stop using KPMG.

The myth of too big to fail

One of the bigger dilemmas relating to the KPMG issue is the question of whether the firm is too big to fail. As an employer of thousands of professionals in the country the firm has a significant contribution to make. To that end there is some merit in saying that the firm needs to be saved rather than decimated. The irony of this of course takes me back to last year when we were deliberating about audit rotation. One of the issues I highlighted is the issue of the monopolistic behaviour of the Big 4 cartel being dangerous for the state.

In essence, the Big 4 are called such because they perform the majority of the audits within the country. However, a vicious circle exists in this market. In the absence of compulsory audit rotation, firms outside the Big 4 quite simply never bother to scale up their operations as they have no chance of ever securing the big audit contracts. The consequence of that state of affairs is that whenever there is a need for a big client to move to another firm, it inevitably finds that the only firms that have the skills set to conduct that audit are fellow members of the Big 4. The musical chairs phenomenon is therefore a big problem when it comes to the auditing profession. It creates a concentration phenomenon in the market which leaves with a significant risk when one of the Big 4 fail.

So as I argued last year, what is needed in South Africa is the market diversification that will mean that we are not held to ransom by the Big 4 simply because no one else has sufficient capacity to replace Big 4 audit teams when we need to replace them. This unfortunately requires the intervention of an external hand to disrupt the market. Audit rotation is but one such instrument.

In simple terms, we are now seeing the consequences of failing to enforce market diversification sooner. Even now, when I look at the implementation date for audit firm rotation being 2023, I am thinking that we cannot wait that long actually.
There is also the need to confront the hypocrisy that we have seen around the question of whether KPMG is too big to fail. Those who say so seem to operate on the premise that KPMG’s employees are some social invalids who need us to protect their jobs. This is rubbish.

KPMG primarily employs individuals who are experts (or at least we used to think they were) in their field. These are not low-level blue-collar workers whose ability to migrate across jobs is limited. If one compares this to the question of how we all advocated for the closure of Gupta companies, there is this tendency to advance the argument of too big to fail for KPMG but no such argument for Optimum Coal for example. This is bizarre because if one looks at which group of employees is likely to be permanently locked out of the job market should the company they work for shut down thanks to the conduct of its key personnel, then the Gupta employees are far more deserving of our sympathy.

The question of how KPMG ever ended up in such a position is still an abiding mystery. There is now a sense that in its pursuits of profits, KPMG started slacking in its internal controls and simply lost its way. In other words, just like poor old Pip, the richer and bigger the firm became, the poorer it turned out to be.

False new path

As it stands today, KPMG appears to be searching for its own identity within the depths of a crisis of its own engineering. Late last year, the firm committed to cleaning up its ways and appointed a brand new executive committee. Unfortunately, the clean-up philosophy that was communicated to the public does not seem to have even been adopted by the same executive committee tasked with overseeing it. To have a partner in charge of one of its key departments committing the type of nonsense that has been revealed in the VBS case, indicates that all we
were subjected to were cosmetic statements of intent which no one had any intention of implementing. Having been so savaged by the politically-exposed work relating to SARS and the Guptas, logic dictates that the most important thing for KPMG to have done even last year was to specifically focus on other clients with a political association. Whether one thinks it is warranted or not, the VBS loan to JG Zuma inevitably meant that they dragged themselves
into the periphery of modern-day politics. How KPMG could then fail to ensure that of all its clients – this is the one to audit thoroughly and without fault – is the single most compelling reason why we should avoid feeling sorry for the firm.

In just the VBS matter, KPMG failed society more than it failed its own client. Because in exhibiting that even its most senior employees have failed to grasp the gravity of what is going on, KPMG has just indicated to the market that its problems are deeply entrenched and may not be resolved by the current role players. Never before in South Africa have we seen the shoddiness of the work performed in the VBS audit by PwC and KPMG.

If 2 prominent Big 4 firms cannot even audit the financial statements of a bank with such a low capital base, one naturally has to wonder what on earth they are doing in the auditing world to begin with. As a result of this, the scepticism that auditors are supposed to exercise in conducting their work has been shown to be a fallacy. Rather, the only scepticism that now exists is that we are now more suspicious of the auditors and will from now on hesitate to believe anything they say.

The rot runs deep

When one looks at the state of the profession today, questions have to be asked about the custodians of the profession. Between the Independent Regulatory Board for Auditors and SAICA, there clearly exists a yawning gap in oversight abilities and competencies. For a young person in a university today planning on becoming a CA one day, it must be a thoroughly confusing time to observe the state of the profession. But this does not surprise some of us.
Take the board of SAICA for example. The moment one hears that a board exists, the impression you get is that they are responsible for overseeing the governance of the organisation. And importantly, CAs and auditors are the type of people who comment and evaluate other companies’ governance systems so you would expect them to practice what
they preach. And you would be completely wrong.

Firstly, the manner in which the board itself is constituted is an obscure process of co-option and musical chairs. Members of the institute – the thousands of CAs out there, have absolutely no idea what the board does save for ensuring that the sandwiches are warm enough at the AGM. If they had any understanding of the crisis that exists in the profession right now, the best they could have done is explain to their members why and how they have formed the opinion that KPMG should remain the auditors of SAICA.

Once that question is answered – which it won’t – they could be invited to explain how they have figured out that during the greatest crisis in the history of the profession – they have taken the decision to send the CEO to secondment on the State Capture Commission. If they answer that question – which they obviously won’t – members of the profession should be able to ask how on earth SAICA believes it can conduct an independent inquiry into its own auditors. Because surely these human beings should understand how perceptions of independence are important here right?

To expect individuals within KPMG or anywhere else to take SAICA seriously in its investigation is a pipedream. When the custodians have lost credibility in this manner you have probably reached rock bottom as the profession and need to take a step back and do a bit of soul searching.

Time for soul searching

The first thing that would need to happen is that the board actually becomes a proper governance structure that seeks to protect the profession rather than protect the Big 4 cartel.
To do this, you would imagine that a board with diverse skills and backgrounds would be ideal. As it stands right now, SAICA’s interpretation of proper oversight requires interrogation.

Currently, the board has 20 members who have one distinguishing feature – they are all CAs. If any other board of an organisation anywhere in the country had such a board we would legitimately question where the diversity of views and skills is. And yet SAICA itself gets away with it. Additionally, this board should consider the question of whether its leadership positions can be occupied by leaders of the Big 4 auditing firms. Currently the chairman – Lwazi Bam – is the CEO of Deloitte. This wouldn’t be a problem if Deloitte was not currently involved in the Steinhoff and African Bank sagas. The problem is that in his capacity as the chairman of SAICA he can say we are cleaning up the profession. And then in his capacity as the CEO of Deloitte, he then has to defend the firm which has clearly damaged the profession in its Steinhoff conduct. Similarly this week, PwC were finally fired as internal auditors of VBS Bank.
This comes after they were also fired from the SAA audit alongside Nkonki when it turned out their work was difficult to reconcile with reality. So guess what – the CEO of PwC serves as a member of the board. Are we to believe that this board is actually going to lead the clean-up of this profession?

KPMG, Deloitte, Nkonki and PwC have currently led the war of destroying the credibility of the profession. The mistake we would make is failing to appreciate that all parts of the ecosystem are broken. Members of SAICA may not necessarily work for any of these firms, but they do look up to SAICA to play a role as the custodian of the profession and lead the renewal process. Unfortunately what we currently have is a board that is clearly not fit for purpose. It is tone deaf, invisible, ill-advised and clearly not suited for purpose. The only logical thing is
for the members of the profession to excuse the current office bearers from their roles. On the 26th of June 2018, the annual general meeting will be held at the Fricker Road offices. By the time we get there, the Ntsebeza inquiry would have given us yet another set of reasons why it has not completed its work. Markus Jooste, Anoj Singh, James Aguma and their entire WhatsApp group will still be members in good standing. Its CEO will be absent. The profession
will still be in tatters.

Interestingly, even if you have no interest in relieving this current board of its duties, there is another good reason to attend the AGM. It is at this meeting where the annual financial statements and the annual report of SAICA will be tabled. And guess who the esteemed auditors that will table those results are – KPMG.